Defend Trade Secrets Act and What It Means

After 5 years in the making, the Defend Trade Secrets Act of 2016 (the “DTSA”) was signed into law today by President Obama (following a unanimous vote by the Senate (87-0) and nearly unanimous vote by the House (410-2)).

Summary

At a very high level, the DTSA creates a federal private right of action for companies seeking to protect their trade secrets; gives automatic access to federal courts; provides a (very limited) right to seize property “necessary to prevent the propagation or dissemination of the trade secret”; permits the recovery of treble damages and attorney’s fees; and (to obtain those enhanced damages) requires companies to provide notice that employees have the right to confidentially disclose trade secrets (to government authorities and attorneys) for the purpose of reporting or investigating a suspected violation of law or in a sealed complaint or other sealed court (or other proceeding) filing.

From a timing standpoint, the most critical aspect of the DTSA is that to obtain the enhanced damages and attorney’s fees available in a trade secrets case under the EEA, companies should provide the required notice (discussed below) to their employees “in any contract or agreement with an employee that governs the use of a trade secret or other confidential information.” (Note that this requirement applies only to contracts or agreements entered into after the DTSA’s enactment.)

Background

The Economic Espionage Act of 1996, 18 U.S.C. §§ 1831-1839, was enacted in 1996 to criminalize the misappropriation of trade secrets. It has two operative sections: Section 1831(a), covering “economic espionage” (i.e., theft of trade to benefit a foreign power), and section 1832(a), covering “theft of trade secrets” (i.e., the theft of trade secrets to benefit someone other than the owner of the secrets).

While those efforts progressed slowly, two other amendments to the EEA sailed through.

Theft of Trade Secrets Clarification Act of 2012

First, adopted on December 28, 2012, the Theft of Trade Secrets Clarification Act of 2012, amended the EEA in response to the headline-grabbing case, US v. Aleynikov, 676 F.3d 71 (2nd Cir. 2012), in which a Goldman Sachs programmer’s conviction under the EEA was reversed based on a narrow interpretation of the EEA’s then-existing language.

The Theft of Trade Secrets Clarification Act expanded the reach of the EEA by deleting the old language (section 1832(a)) that protected only trade secrets “related to or included in a product that is produced for or placed in interstate or foreign commerce” and replacing it with language expanding the scope of trade secrets covered by the EEA to those “related to a product or serviced used in or intended for use in interstate or foreign commerce.”

The new language reads as follows (deleted language is crossed out, added language is bolded):

Whoever, with intent to convert a trade secret, that is related to or included in a product that is produced for or placed ina product or service used in or intended for use in interstate or foreign commerce, to the economic benefit of anyone other than the owner thereof, and intending or knowing that the offense will, injure any owner of that trade secret, knowingly

The bill was to designed to, and did at least in part, address the Second Circuit’s decision in US v. Aleynikov, 676 F.3d 71 (2nd Cir. 2012). However, by deleting the phrase “or included in” from the current statute, the bill may have created its own ambiguity insofar as it can be viewed as attempting to somehow limit the scope of the prior language. (This issue is for another day.)

The DTSA’s Amendments to the EEA

Federal Private Right of Action (Section 1836(b))

Perhaps the single most significant aspect of the DTSA is that it creates a federal private right of action for owners of trade secrets seeking to protect their trade secrets. This is potentially a game-changer, putting trade secrets (the largely ignored, but fastest-growing category of intellectual property) on equal footing with patents, copyrights, and trademarks, at least insofar as there is now federal private protection. (While there still is no federal registration, one might wonder whether there will be one in time – even if only to establish timing of ownership or notice of the existence of the secret (without of course disclosing it publicly). A controversial concept, I know!)

Federal Court Access (Section 1836(c))

Concomitant with the federal private right of action is the right to bring a trade secret misappropriation case in federal court. It bears noting, however, that jurisdiction does not lie exclusively in the federal courts; state courts have concurrent jurisdiction. (While the original EEA provided for exclusive original federal court jurisdiction, the DTSA eliminated that language and replaced it with language providing for only “original jurisdiction” in the federal courts.)

If the goal is to file in state court and stay out of federal court (assuming no diversity of citizenship or other federal cause of action), a trade secret owner will need to forgo the rights and remedies of the EEA, and bring the action exclusively under state trade secrets laws (and other state laws).Bringing an EEA claim will otherwise run the risk of having the case removed to federal court on the eve of a hearing on an emergency motion.

Ex Parte Seizure Orders (Section 1836(b)(2))

Hands down, the most controversial aspect of the DTSA and its predecessors has been the ex parte seizure provisions.

Under the amended EEA, not only may owners (including licensees) of a trade secret bring a civil action, but “in extraordinary circumstances,” they can obtain an “order providing of the [ex parte] seizure of property necessary to prevent the propagation or dissemination of the trade secret that is the subject of the action.”

To establish the right to the order, the trade secret owner must meet significant stringent requirements, including establishing that the injunctive relief otherwise available is insufficient, describing “with reasonable particularity the matter to be seized” and its location, and proving that if notice were provided, the person against whom the order would issue “would destroy, move, hide, or otherwise make such matter inaccessible to the court . . . .” In addition, the trade secret owner cannot publicize the requested seizure and the court’s order will need to protect against publicity relating to the order.

In addition to other safeguards, if an order is issued, a hearing must follow as soon as possible, and, in any event, within seven days of the order. If the court determines that the order was wrongfully obtained or excessive, the injured party “shall be entitled” to the relief provided for under the Trademark Act of 1946, 15 U.S.C. 1116(d)(11), which provides:

A person who suffers damage by reason of wrongful seizure under this subsection has a cause of action against the applicant for the order under which such seizure was made, and shall be entitled to recover such relief as may be appropriate, including damages for lost profits, cost of materials, loss of goodwill, and punitive damages in instances where the seizure was sought in bad faith, and, unless the court finds extenuating circumstances, to recover a reasonable attorney’s fee. The court in its discretion may award prejudgment interest on relief recovered under this paragraph, at an annual interest rate established under section 6621(a)(2) of the Internal Revenue Code of 1986, commencing on the date of service of the claimant’s pleading setting forth the claim under this paragraph and ending on the date such recovery is granted, or for such shorter time as the court deems appropriate.

The concern about the seizure provision is two-fold: (1) it can be abused; and (2) although designed for the federal courts, the provision can be used in the state courts as well, where some people feel that the quality or experience of the bench may not be suitable.

Remedies (Section 1836(b)(3))

Like the Uniform Trade Secrets Act from which the EEA derives much of its relevant language, the EEA provides not only for injunctive relief (see below), but for the recovery of “actual loss” (what people generally think of as, primarily, lost profits), unjust enrichment damages that is not included in actual loss, and in lieu of the above, a reasonably royalty. (See UTSA, § 3.)

Also like the UTSA, the EEA provides for exemplary damages (double the damages award, for a total of treble damages) for willful and malicious misappropriation.

Again taking its cue from the USTA, the EEA permits an award to the trade secret owner when the misappropriation was willful and malicious, and to either side when the other litigates in bad faith.

Immunity and Related Notice Requirement (Section 1833(b))

The DTSA was amended late in the game to make it clear that an employee (defined to include an independent contractor) has the right to disclose trade secrets and other confidential information in limited circumstances related to the reporting or investigation of suspected illegal conduct or in confidential filings (i.e., filings under seal) in a lawsuit or other proceeding. Specifically, as to the latter, any disclosure must be made (1) in confidence (2) to a federal, state, or local government official, or to an attorney (3) “solely for the purpose of reporting or investigating a suspected violation of law . . . .”

For an employer to qualify for recovery of the EEA’s enhanced damages (exemplary damages and attorney’s fees), it must provide notice of the immunity “in any contract or agreement with an employee that governs the use of a trade secret or other confidential information.” Such agreements may include the obvious (like nondisclosure agreements, confidentiality agreements, and noncompetes) and the not-so-obvious (like severance and separation agreements that contain confidentiality provisions).

The notice can be in the agreements themselves or simply reference the employers’ reporting policy (in, for example, an employee handbook).

It is important to know that the notice requirement applies only to agreements entered into after the DTSA’s enactment. Accordingly, existing agreements are not subject to the notice requirement.

Impact on the Inevitable Disclosure Doctrine (1836(b)(3))

As noted above, the DTSA (like the UTSA (section 2)) authorizes the issuance of injunctions to prevent any “actual or threatened misappropriation . . . .”

This language (as it appears in the UTSA) has been interpreted by some courts to permit (albeit in limited circumstances (a discussion for another day)) a court – even in the absence of a noncompetition agreement – to prevent an employee from working for a competitor in a job in which the employee’s work would inevitably lead to the use or disclosure of the former employer’s trade secrets (because, in theory, at least, the secrets are remembered by the employee). The doctrine, known as the “inevitable disclosure doctrine,” originated in PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995).

Given the similarity of the language, to prevent the EEA from being used to create a de facto noncompete (where the employee merely remembers trade secret information from a prior employer), the DTSA expressly states that an injunction may not “prevent a person from entering into an employment relationship” and any “conditions placed on such employment shall be based on evidence of threatened misappropriation and not merely on the information the person knows . . . .”

The actual impact of this language remains to be seen. For example, the inevitable disclosure doctrine typically applies only when there an employee engages in wrongful conduct (not where the employee merely remembers information). Accordingly, the doctrine is not applied quite as expansive as the limiting language in the EEA would suggest. In addition, the EEA’s language does not appear to preclude reliance on the inevitable disclosure doctrine under state trade secret laws. Time will tell how this will all shake out.

Exceptions to Misappropriation (Section 1839(5))

The conduct that constitutes misappropriation of trade secrets will be familiar to lawyers who practice in this area; it is the same conduct defined in the UTSA (section 1(2)): acquisition through improper means (as defined in the UTSA)) and wrongful disclosure or use of a trade secret (as defined in the UTSA). (Each of those is detailed in the statute.)

While the UTSA (in the comments) identifies exceptions to conduct that might otherwise constitute misappropriation (most notably, reverse engineering and “independent invention”), the DTSA includes reverse engineering and “independent derivation” as exceptions (in text). The fact that the exceptions appear in the body of the statute is of no moment. What is significant, however, is the difference in the language: “independent derivation” arguably suggests that the misappropriator can cleanse his or her conduct by modifying a stolen trade secret and then using only the modified secret. In contrast, “independent invention” presumes that the invention did not start with (i.e., derive from) a misappropriated trade secret.

Additional Changes Not Included in the Amended EEA

In addition to the amendments to the text of the EEA, the DTSA makes several other changes to existing law.

First, the DTSA makes the violation of the EEA a predicate offense under RICO.

Second, the DTSA requires that within the first year after the DTSA’s enactment (and then biannually thereafter), the United States Attorney General (in consultation with the Intellectual Property Enforcement Coordinator, the Under Secretary of Commerce for Intellectual Property and Director of the United States Patent and Trademark Office, and the “heads of other appropriate agencies”) submit to the Committees on the Judiciary of the House of Representatives and the Senate – and make publicly available – a report the status and impact of trade secrets laws domestically and internationally, together with a recommendation for reducing the threat, educating and providing assistance to US companies, and providing a mechanism for US companies to confidentially or anonymously report international trade secrets theft.

Third, Congress expressly states its perception (among other things) that the Economic Espionage Act “applies broadly to protect trade secrets from theft . . . .” Accordingly, expect to see an expansive reading of the language, given that the statute seems designed to temper the rule of lenity (i.e., the canon of construction that requires a narrow interpretation of statutes that are both criminal and civil, when the intent of the legislature is not otherwise clear).

Fourth, recognizing that the seizure rules need “to balance the need to prevent or remedy misappropriation with the need to avoid interrupting the (A) business of third parties; and (B) legitimate interests of the party accused of wrongdoing,” the DTSA requires the Federal Judicial Center, within two years of enactment (with occasional updates), to develop recommended best practices for “the seizure of information and media storing the information” and “the securing of the information and media once seized.” As with the Attorney General’s report, this report is to be provided to the Committees on the Judiciary of both the House of Representatives and the Senate.

Where are we headed?

The actual impact of the DTSA remains to be seen. I do not believe that there will be significant use of the much-feared ex parte seizure procedure. I do, however, believe that there will be a significant increase in trade secrets litigation in the federal courts.

I also believe that, with the UTSA-like standards now part of a federal private civil cause of action, the two remaining states, Massachusetts and New York, are more likely to adopt the Uniform Trade Secrets Act, at least in some form. (Note that technically North Carolina has not adopted the UTSA; however, given that the North Carolina Trade Secrets Act (adopted in 1981, after the original version of the UTSA, but before the current 1985 version) tracks significant concepts, if not language, from the UTSA, I view it as a distinction without a difference.)

As a related matter, people tend (appropriately) to couple legislative efforts to adopt stronger trade secrets laws (like the EEA) with efforts to reform noncompete law (designed in large part to protect trade secrets). Putting aside the wisdom of giving with one hand (enhancing pure trade secrets laws) while taking with the other (cutting back on noncompete protections), the issues are related and have very different approaches and implications. (As noted in Changing Noncompete | Trade Secrets Laws, many states – and even the federal government and others – are looking into modifying noncompete laws (many to restrict their use, while some have gone or are going in the other direction).)

In some cases, non-compete agreements can play an important role in protecting businesses and promoting innovation. They can also encourage employers to invest in training for their employees. However, as detailed in this report, non-competes can impose substantial costs on workers, consumers, and the economy more generally. This report informs future discussions and potential recommendations for reform by providing an overview of the research on the prevalence of non-competes, evidence of their effects, and examples of actions states are taking to limit the use and enforcement of unnecessary non-competes.

There is more work to be done. The Administration will identify key areas where implementation and enforcement of non-competes may present issues, examine promising practices in states, and identify the best approaches for policy reform. Researchers must continue to assess and identify promising policy reforms and the potential impact of those reforms including unintended consequences. Ultimately, most of the power is in the hands of State legislators and policymakers in their ability to adopt institutional reforms that promote the use and enforcement of non-competes in instances that appropriately weigh their costs and benefits in ways that provide workers appropriate transparency about their rights.

In light of all of this, I think we will see continued and escalating efforts to find the appropriate balance between the use and enforcement of noncompetes and the mobility of employees.

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